Pre-FAS 133, hedge accounting meant
deferral of gains/losses. Deferral accounting, as such,
is no longer possible. But the timing of recognition of
gains/losses can be tweaked to match that of the
underlying exposure under FAS 133 (as long as the hedge
and hedged item qualify for one of FAS 133’s basic hedge
relationships: Cash Flow, Fair Value or Net Investment;
for basic FAS 133 terminology, see FAS
133 “101” Lesson 2.
In some cases, special accounting
means accelerating the losses/gains on the exposure into
income to match the gains and losses on the derivatives
(e.g., fair value hedges). In other cases, it means
“parking” the derivative gains/losses in OCI (outside
income) until the exposure materializes. Either way, the
effect is the same: Volatility due to the timing
mismatch is reduced.
Whether or not companies can qualify
for special accounting depends on a host of factors. FAS
133 has very specific rules about what sorts of
derivatives and what sorts of exposures can be hedged.
But more than anything, special accounting depends on
whether changes in the fair value of the hedge will
prove a highly effective offset to changes in the fair
value of the designated exposure. What’s highly
effective? That’s where the effectiveness test comes
in.
